United Utilities Group (LON:UU.) Could Be Struggling To Allocate Capital

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after investigating United Utilities Group (LON:UU.), we don't think it's current trends fit the mold of a multi-bagger.

What Is Return On Capital Employed (ROCE)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for United Utilities Group:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.038 = UK£543m ÷ (UK£15b - UK£729m) (Based on the trailing twelve months to September 2022).

Thus, United Utilities Group has an ROCE of 3.8%. Even though it's in line with the industry average of 3.9%, it's still a low return by itself.

See our latest analysis for United Utilities Group

In the above chart we have measured United Utilities Group's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering United Utilities Group here for free.

The Trend Of ROCE

When we looked at the ROCE trend at United Utilities Group, we didn't gain much confidence. Around five years ago the returns on capital were 5.7%, but since then they've fallen to 3.8%. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.

In Conclusion...

To conclude, we've found that United Utilities Group is reinvesting in the business, but returns have been falling. Since the stock has gained an impressive 88% over the last five years, investors must think there's better things to come. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

One final note, you should learn about the 2 warning signs we've spotted with United Utilities Group (including 1 which makes us a bit uncomfortable) .

While United Utilities Group may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.